1. Chapter 17-Cafeteria Plans
Rationale for Use
To make employees more aware of benefits by giving them a dollar amount to spend
To better meet the needs of a diverse group
To enable employers to pass on increasing costs of benefits;

2. Definition Any benefit plan that allows employee choice
Technically, it is a plan that meets the requirements of section 125 of the IR Code; a plan under which all participants may choose between two or more benefits consisting of qualified benefits and cash
Cash – actual receipt of dollars; a benefit provided on a taxable basis as long as it is not prohibited by section 125

3. So what are qualified benefits?
Any welfare benefit excluded from taxation under IRS code except scholarships and fellowships, transportation benefits, educational assistance, and employee discounts
Group term life insurance in excess of $50,000
A 401(k) plan but not other deferred compensation plans

4. Benefit Election Must be made prior to beginning of plan year
Cannot be changed during plan year unless allowed by plan AND for one of these reasons:
Changes in family status
Separation from service
Cessation of required contributions
Plan cost changes
Plan coverage changes

5. Payroll Deductions & Salary Reductions
Flexible spending accounts: Pre tax contributions:
Used primarily for medical, dental & dependent care expenses
A separate election for each benefit must be made prior to beginning of plan year and can only be changed under certain circumstance
Monies in employee accounts are forfeited to company if not used during the year
Election reduces taxable income and wages on which social security taxes are paid
There is some risk for employer since the full annual amount must be available at any time

6. Types of Plans Core-Plus Most common type of cafeteria plan
Basic core is provided to all employees, plus a second layer of ‘optional’ benefits is offered
Additional benefits may be purchased with employer contributions and possibly, after-tax employee contributions

7. Types of Plans
Modular
Employees choose among several pre-designed benefit packages
One package usually at no cost; others require employee contributions, usually through payroll deductions
Growing in popularity as adverse selection is more easily controlled and plans are easier to communicate and administer

8. Types of Plans Salary-reduction Only
Can be stand alone or be part of a broader cafeteria plan
Premium conversion plan (also called a premium only plan –POP- ) allows an employee to elect a before tax salary reduction to pay his/her contribution to benefits; for example, dependent care health insurance coverage paid in full by employee; for medical and dental expenses only as otherwise there are tax consequences
FSA- flexible spending accounts – fund certain benefits on a before tax basis; again, for medical and dental expenses not covered by employer’s plan or for dependent care expenses

9. Obstacles to Use Legislation; rules are clear, but still changing
Meeting non-discrimination rules:
No more than 25% of tax-favored benefits can be provided to key employees
Eligibility test
Employees with at least 3 years of service must be allowed to participate
Eligibility rules must not discriminate in favor of highly compensated employees

10. Obstacles to Use Negative Attitudes Employer obligations
Employees: if their support isn’t gotten in advance
Unions: who feel they should bargain for what’s best for employees
Insurers: who are conservative and worry about adverse selection
Employer obligations
If unused, will morale suffer?
Will faulty choices by employees create liability for employer?

11. Obstacles to Use Costs Adverse selection
Initial start-up costs are modest
Continuing administrative costs are higher, but software
Adverse selection
It is a problem, when choice is allowed
Methods for controlling:
Limitations and restrictions when changes are made
Proper pricing of options
Minimal benefits for certain coverages

12. Issues in Plan Design Level of employer contributions
May be based on factors such as salary, age, family status, length of service
Should be large enough that employees can purchase benefits at least equivalent to prior plan
Types and amounts of benefits to include
Collect employee input to improve offerings
There must be a balance between needs and costs

13. Change of Benefits It is costly and increases adverse selection
Usually allowed no more than once per year